Highlights

• Weaker 1Q16 … Petronas 1QFY16 PAT excluding identified items came in at RM5.5bn, down 53.3% YoY primarily due to weaker overall performance for both Upstream and Downstream business divisions.
• Upstream: PAT for the division plunged by 71.1% YoY in the quarter primarily due to significantly lower crude oil prices evident in its concurrent 30.2% drop in top line YoY and lower LNG volume due to lower production from Petronas LNG Complex in Bintulu, Sarawak. The decrease in profitability was seen despite pick up in overall production volume with entitled crude oil production up by 6.5% YoY mainly due to higher Iraq oil production and new production from Indonesia. Gas volume nudged up by 10% YoY due to higher gas demand in East Malaysia.
• Downstream: Less exciting development in this division compared to last year with its PAT down by 42.4% YoY no thanks to significant downward trend in oil product and petrochemical prices in the quarter, resulting in weaker refining margins. This is an indication of the refining industry normalizing with its product prices gradually readjusting downwards, stealing away the supernormal refining margins earned by refiners in 2015. Overall volume was mixed with petrochemical volume up by 6.3% YoY being offset by weaker petroleum products and crude oil sales volume registered in the quarter.
• Operational cash unable to cover commitments? At the current rate, cas h flow generated from the group’s business at the current oil price scenario appears to be insufficient to meet its cash commitments in the year. In the current quarter, the group had only generated RM9.8bn compared to RM17.3bn last year. Assuming full year cash flow of RM40bn for 2016 through simple annualizing, the group would still have RM12.5bn shortfall assuming that the group intends to cut its CAPEX budget to RM52.5bn from circa RM65bn.
• How would the shortfall be covered? One of the possibilities would be debt fund raising given its comfortable net cash position, which would be a comfort pill for the already battered down upstream services players. Another scenario would be the option to further reduce Upstream CAPEX and OPEX, which would make business senses for the current scenario and this would further impair local ups tream services players ’ near-to-medium term earnings outlook.
• Nobody would be spared... Aside from upstream, we believe RAPID would also be affected by the current situation and we do not discount the possibility of deferment of projects and even delays in commencement of certain projects to provide breathing room for Petronas group. Cost rebasing is still ongoing even for the downstream sector with certain projects with approved FID being subjected to retender process at advanced stage according to channel checks.

Rating

NEUTRAL

Positives

• Earlier than expected oil price recovery.

Negatives

• Delay in contract rollout and low oil price environment lead to competition and margin compression.

Valuation

• Prefer Armada (Buy; TP: RM1.01) as a trading undervalued play. We believe contract termination risks are overplayed on the stock given the company’s more favorable pos ition in its FPSO contracts.

Source: Hong Leong Investment Bank Research - 19 May 2016